[pash]

It's usually called a liquidity spiral. Brunnermeier and Pedersen's 2009 paper [0] is the standard reference. For a quick overview, see their slides [1] or Pedersen's summary for Vox EU [2].

As Pedersen emphasizes in the Vox article, the amount and price of funding available to participants in financial markets is intimately related to macro factors. So market liquidity, through the funding linkage, can dive along with the real economy.

But liquidity can also evaporate due to endogenous factors, particularly when markets are set up so that the funding available to traders depends on the price of the asset being traded, e.g., through margin rules. That's what seems to have happened on BitFinex today. Positive feedback loops make for ill behaved markets.

0. http://pages.stern.nyu.edu/~lpederse/papers/Mkt_Fun_Liquidit... [PDF]

1. https://www.newyorkfed.org/registration/research/risk/peders... [PDF]

2. http://www.voxeu.org/article/understanding-liquidity-risk-an...

[sillysaurus3]

Is the grandparent comment otherwise correct, besides the name?

[domdip]

Well, the original article makes a claim that this was caused by a margin call feedback loop (thanks pash for finding the right term and some analysis).

There could be other causes. It's hard to untangle whether BitFinex caused the other exchanges to drop, or if it just dropped faster due to margin but had no real effect on the other exchanges.